Tax Milestones

Your local store probably carries special cards for the birthdays that tend to be milestones in ordinary life. Although taxpayers shouldn’t expect to receive cards from the IRS, some birthdays are especially important for tax purposes, too.

Birth. You generally can start claiming a dependency exemption for your child in the year he or she is born. In 2013, the exemption is $3,900, subject to phaseout for higher income taxpayers.

13. The child care credit is available to eligible working parents until the year their child turns 13. The credit is 20% to 35% of employment-related child care expenses, depending on income. The maximum amount of expenses eligible for the credit is $3,000 for one child and $6,000 for two or more.

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American Taxpayer Relief Act —
A Closer Look

Now that the flurry of the year-end fiscal cliff negotiations has passed, taxpayers are digging into the details of the American Taxpayer Relief Act of 2012 to get a better idea of how it affects their personal and business taxes. Here’s a closer look at some key provisions.

Income-tax Rates
For 2013 and subsequent tax years, the 10%, 15%, 25%, 28%, 33%, and 35% income-tax rates will remain in place. However, a higher 39.6% rate will apply to income over a specified amount: $400,000 for single taxpayers, $450,000 for married taxpayers filing jointly, $425,000 for taxpayers filing as head of household, and $225,000 for married taxpayers filing separately.

The new law brings back provisions limiting itemized deductions and phasing out personal exemptions, effectively increasing the rates higher income taxpayers pay. The itemized deduction and personal exemption provisions are triggered when income exceeds $250,000 (single), $300,000 (married filing jointly), $150,000 (married filing separately), and $275,000 (head of household).

AMT Relief
The alternative minimum tax (AMT) has trapped a growing number of taxpayers each year, and it promised to ensnare millions more middle-income taxpayers in 2012 unless Congress again enacted a “patch.” The new law providespermanent AMT relief, retroactive to 2012, by increasing the AMT exemptions and indexing them for inflation. The 2012 AMT exemption amounts are $50,600 for unmarried taxpayers, $78,750 for married taxpayers filing jointly, and $39,375 for married taxpayers filing separately.

Capital Gains and Dividends
Starting in 2013, single taxpayers with income over $400,000 ($450,000 for married taxpayers filing jointly, $425,000 for heads of household, and $225,000 for married taxpayers filing separately) will pay a 20% rate on most long-term capital gains and qualified dividends. For other individuals, the top rate remains fixed at 15% (0% for those in the two lowest brackets).

Estate and Gift Taxes
Instead of falling to $1 million as scheduled, the amount exempted from estate and gift tax will stay at $5 million, indexed for inflation. The top estate- and gift-tax rate rises from 35% to 40% (rather than 55%) after 2012.

Business Tax Breaks
For tax years beginning in 2012 and 2013, business taxpayers may elect Section 179 expensing for more of their qualifying asset purchases — up to $500,000 each year, subject to phaseout as qualifying asset purchases exceed $2 million. In addition to equipment and other items normally eligible for expensing, certain real property can qualify. The new law also extends 50% bonus first-year depreciation, generally through 2013, and temporarily revives the research credit, the work opportunity tax credit, and certain other tax credits important to businesses. 

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Make Some New Year’s Tax Resolutions

The new year brings with it another tax filing season. It’s also an opportunity to start over and look for ways to improve your tax situation. You’ll be in a better position to benefit from available tax breaks and to reduce your tax burden in the new year and beyond if you resolve to:

Get Your Tax Records Together

Commit now to compiling all the receipts and other tax records that will be needed to prepare your 2012 tax return. Without appropriate records, you could lose out on deductions. On the income side, look for W-2 and 1099 forms to start arriving this month. If items are missing, track them down. And, while you’re spending time with your tax records, put a filing system in place for your 2013 information.

Review Your Tax Withholding

The amount of federal income tax that is being withheld from your paychecks is a result of how you filled out Form W-4 with your employer. Receiving a large tax refund means that you are essentially giving the government an interest-free loan. By revising your W-4, you can reduce the amount of tax withheld — and see more money in every paycheck. By the same token, you’ll want to be sure you are having enough withheld to avoid underpayment penalties.

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Don’t Be Caught by Surprise

For much of 2012, uncertainty about the fate of various favorable tax law provisions set to “sunset” at the end of the year has complicated tax planning. Although the situation may change, at the time of publication, taxpayers are still waiting for answers from lawmakers and weighing what planning steps, if any, they should take before year-end.

Key questions include:

Will individual income-tax rates be higher in 2013?

Will capital gains rates increase?

Will qualified dividends lose the benefit of lower rates?

Will a decreased exemption make more estates vulnerable to estate tax after 2012?

Until issues like these are resolved, taxpayers making important financial decisions may find it helpful to have projections of the potential tax effects of those decisions run under different tax law scenarios. Projections can provide a clearer up-front understanding of the possible tax impact.

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Make Sure Your Tax Payments Are on Track

The IRS doesn’t wait until returns are filed to collect income taxes from taxpayers. Most people are required to pay tax during the year by making quarterly estimated tax payments to the IRS or having their employers withhold income taxes from their paychecks. It’s important to pay at least as much estimated tax as the tax law requires so you won’t owe an underpayment penalty.

How Much Is Enough?

The total amount of estimated tax you’re required to pay depends on your adjusted gross income (AGI) for the previous year. If your 2011 AGI was $150,000 or less ($75,000 or less as a married taxpayer filing separately), you should aim to pay the lower of:

•  90% of your 2012 tax liability or
•  100% of your 2011 tax liability.

If your 2011 AGI was more than $150,000 ($75,000 as a married taxpayer filing separately, pay the lower of:

•  90% of your 2012 tax liability or
•  110% of your 2011 tax liability

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Tax Smart or Tax Pitfall?

Most taxpayers are looking for ways to minimize their taxes. But some tax moves that seem smart for one reason turn out to be tax pitfalls for another. Here are some examples of what can happen.

Family Gifts

Properly structured lifetime gifts of securities, real estate, or other property can help minimize future estate-tax exposure by removing the gifted property from the donor’s future estate. If the property increases in value or earns income after it’s given away, that appreciation or income generally isn’t included in the donor’s estate. Because no one knows for sure what Congress will do with estate-tax rates and exemptions after 2012, giving property to children or other heirs can be a smart tax move.

But not always. There’s a potentially significantincome-tax advantage to inheriting property rather than receiving it as a gift.

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The Alternative Minimum Tax Trap

When the alternative minimum tax (AMT) system was introduced in the early 1980s, it was intended to prevent a small number of taxpayers with substantial economic income from completely avoiding federal income taxes through the use of exclusions, deductions, and credits. The idea was to have those taxpayers do a secondary tax computation and then pay the higher of their “regular tax” or the tax determined under the AMT computation.

A Wider Reach

Today, the secondary tax computation concept remains largely in place. But the AMT’s tentacles have reached far beyond the small group targeted by the original AMT legislation. Every year, millions of taxpayers who don’t consider their tax situations at all unusual are surprised to find they owe the AMT.

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It pays to be careful when moving money from one traditional individual retirement account (IRA) to another or from an employer’s retirement plan to an IRA. Unless you follow certain guidelines, you may find yourself paying taxes on what could have been a tax-free transaction.

60-day time limit. You can withdraw all or part of the assets from your traditional IRA and reinvest them in the same or another traditional IRA. But you don’t have an unlimited time to complete the rollover. For the transaction to be tax free, you must reinvest within 60 days. The same 60-day time limit applies to rolling over an eligible distribution you receive from your employer’s plan (but see 20% withholding below for another potential trap).

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